Alistair Wilson reports on the effects company takeovers have for bondholders

A growing theme which has been dominating the financial headlines over the past couple of weeks is the return of high profile takeovers.

Most recently (at the time of writing) the focus was on Heinz being acquired by Buffet and 3G Capital for $28 billion, prior to that it was Malone’s Liberty Media Group taking over Virgin Media for $23 billion and before that we had Michael Dell announce he was to take his creation back into private ownership for $24 billion.

All of these deals had the same theme; all were stable cashflow generating businesses that were geared up as part of the takeover. I would describe these deals as ‘positive event risk’ for a company as they typically create windfalls for shareholders.

However, from a bondholder standpoint they are almost always costly to those already holding the debt. A consequence of the increased gearing invariably leads to multi-notch downgrades, often into the junk universe, and is almost always accompanied by a decline in existing bond prices. The new debt that is issued is often quite attractively priced, but for bond managers the great challenge is not to hold bonds leading up to the ownership change.

Virgin Media bonds traded down 12 points following the Liberty announcement, some of the Dell bonds were down 18 points, and Heinz bond-holders have suffered a hit despite the general corporate sector enjoying decent support. The transition from investment grade down to high yield is an expensive one from a borrower’s standpoint.

We believe that with the high volume of cash on the sidelines and a more buoyant investor appetite in the equity markets, this leveraged buyout (LBO) risk is likely to be a key theme in fixed income markets this year.

On the flipside we also have ‘negative event risk’ rearing its ugly head. Hibu (better known to most of us as Yellow Pages) is likely to follow Seat Pagine (Italy’s Yellow Pages) into default later this month. TPSA (Poland’s Orange) had shocking results this week, and in the CEO’s words, are fighting for their existence. KPN, which is Holland’s incumbent telecom operator, is in need of a rights issue to help fund the costly 4G licenses. Then there is Peugeot who this week announced record losses of €5 billion.

As you would expect, for bond holders none of these events was particularly enjoyable. Downgrades and price drops have followed. However, it is not all bad news, for example Renault had a very different result in 2012, and from a bond holder’s perspective now looks to be in very good shape as the company is now essentially free of debt with net cash of €1.5 billion. Then there was Edcon the South African retailer, who tendered their bonds back early. So there are plenty of good stories out there to be found too. 2013 is setting up to be a very different year from last year. 2012 was very much about the recovery of confidence in the bond markets which created a tide that lifted nearly all bond prices in a wave of systemic support.

This year stock selection is likely to play a much larger role in overall performance. In what is likely to be a much more benign year for fixed income investors, we would not be surprised if stock pickers could find up to a third of their 2013 returns coming from this source of alpha, particularly in the more active strategic mandates.

Alistair Wilson is head of institutional business at TwentyFour Asset Management

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